schweser book 5, p112 - 113 the example given on hedging the principal with FX futures shows R(FUT) = - (F[T] - F[0]) / F[0] (negative sign indicates a short position in futures) i think the payoff should be really based off spot price at time T instead of futures price of time T . i.e. R(FUT) = - (S[T] - F[0]) / F[0] since futures are marked-to-market to spot every day. am i wrong on this?
F(T) will equal S(T). In other words the futures price will converge to the spot price on teh expiration date.
" futures are marked-to-market every day. "
Yes, but at time T, I’m assuming Expiration, the futures price would equal the spot price, correct?
That story is close enough to the truth that you should go with it. At expiration, there are still things like delivery options left.
i see what you guys are saying, then is it possible that at time of expiration F[T] > S[T] (a premium charged for certain level of delivery)?
never mind, guys. i knew where i was wrong. my key mistake is to think futures are marked to spot market (as joeydvivre pointed out). so the time T does not have to be the time of expiration. F[T] is simply market price of the contract at time T. i am cool now, thanks guys.
random, it was a valid question. I actually tried a few problems in schweser and CFAI, using this formula I got wrong answers…Most probably I did something wrong. I decided to go with using the long way i.e. using the dollar conversions…again I may be wrong this is what I felt!
I hope nothing I wrote implied it wasn’t a valid question. Level III doesn’t usually have invalid questions. Now on Level I, people post questions like “If I graduated with a 3.6 from a small midwestern college, will I pass the CFA exam with 253 hours of studying?”